More on Greece, the bailout and the Euro

Leaders of countries in the eurozone on Thursday promised to help Greece if it slashed its budget deficit, saying they would provide “determined and co-ordinated action if needed to safeguard stability” in the bloc.

The future of the euro is dark because there are such strong incentives for reckless fiscal behavior, not only for Greece but also for other countries. Some of them are in situations similar Greece’s. In Spain, official unemployment is approaching 20% and public deficit is 11.4% of GDP. Portugal announced a plan to privatize national assets as its deficit is at 9.3% of GDP. Ireland’s housing bubble burst with a deficit of 11.5% of GDP.

And further:

What is the future of the euro? As we have seen, the inherent incentives in the eurozone encourage destruction of the currency because deficit costs are externalized. Therefore, there are three main possibilities.

The Stability and Growth Pact is finally enforced. Unfortunately, strong political resistance makes this possibility unlikely.

The more conservative member states refuse to continue bailing out the more profligate ones. The economically stronger states force the weaker ones to enter bankruptcy and to leave the monetary union.

Countries continue to increase their deficits, attempting to externalize the costs. They yield to the incentives and participate in a spending race, leading to a hyperinflation; and the euro moves closer to collapse.

In the UK the government seems to think the world owes it a living. The administration thinks it can carry on borrowing, with the global money lenders happily paying the bills for the excess public spending. The main difference between Greece and the UK is that Greece belongs to Euroland and expects the EU to bail it out, whilst the UK is outside, and can put off adjustment a bit by devaluing its currency.

The British political debate is shifting. But not nearly fast enough. The gilts market is watching very closely. If there isn’t genuine action soon, or at least a rock solid and credible commitment to action, traders will lose patience and bid-up gilt yields sharply. In a crippling ripple effect, borrowing costs would spike right across the economy. Sterling could even collapse.